12/28/2010 @ 7:00AM

Rethinking Japan's Consumer Appeal

Japan’s recently announced corporate tax cuts of 5% and newly proposed subsidies and tax incentives for overseas firms are unlikely to reverse the country’s economic fortunes on their own. Taxes are still far lower elsewhere in Asia and burdensome regulations will continue to stymie broader economic growth. But many CEOs who instinctively bypass Japan for faster growing markets in China and India, should rethink establishing a presence here.

To be sure, Japan’s economic malaise is well documented. Annual GDP growth over the past 15 years has averaged below 1%. Deflation has been a drag on the economy by deterring borrowing and spending as consumers and businesses postpone purchases waiting for prices to fall and demand to rise. Moreover, decision-making and government bureaucracy is slow, while entrenched relationships often challenge the patience of new market entrants. With China’s economy eclipsing that of Japan’s to become the world’s second largest, a large shadow now obscures investment possibilities.

But Japan as No. 3 still presents opportunities in many sectors due to a large, concentrated population with purchasing power per capita ten times greater than China. Japanese consumers are also showing an increasing acceptance of innovative foreign products and price competition.

Take pharmaceuticals, for example. At $85 billion in annual sales, Japan’s drug market is almost triple that of China’s. Although sales in China are forecasted to increase by 25% next year, roughly four times the rate of Japan, total revenue growth for foreign drug companies will be significantly greater in Japan due to factors beyond market size.

A significant portion of Japan’s growth will be generated in the innovative drug market, benefiting foreign companies that dominate the sector. Conversely, generic drugs, produced almost exclusively by local companies, drive much of China’s expansion. The story is similar in other major emerging markets such as Brazil, Russia and India where combined sales over the next three years will increase, but by roughly $8 billion less than in Japan.

What’s more, Japan’s discriminating and affluent consumers will continue to demand innovative foreign pharmaceuticals. And with the world’s largest percentage of people over the age of 65–23% and growing rapidly–sales in the $25 billion medical equipment market and other health-related industries are set to increase. But opportunities exist beyond Japan’s aging population.

Foreign firms with savvy new high tech offerings are winning over traditionally nationalistic electronics consumers.
Apple
‘s sales jumped 75% this year due to the iPad and iPhone. Now foreign Android phones are making inroads. In addition, innovations within Japan’s $300 billion enterprise IT and services market present new sales possibilities for international companies. Salesforce is opening a research center in Japan while
VMware
is bolstering staff levels to keep up with a doubling in sales it reported earlier this year to capitalize off an expected 20% annual growth in cloud computing.

Many other multinationals, like
Gap
,
Costco
and Amazon, have successfully entered the Japanese market over the past 15 years. Their products and services have helped to change consumer habits in a country with a previous preference for higher-end goods from large department stores. Similarly,
Starbucks
has opened over 900 shops since 1996. It even brought its unique coffee culture to the heart of the Japanese economy: A branch now serves lattes in Japan’s Ministry of Economy, Trade and Industry. The company reported $1.2 billion in sales with stable cash flow and profitable margins.

We are not suggesting that CEOs ignore emerging markets. Certainly countries such as China and India present tremendous expansion opportunities, but they also entail risks generally absent in Japan, such as intellectual property protection problems, onerous local content requirements and nationalist backlashes. Despite its high tax rates and slow growth, Japan has a relative opportunistic business environment. The World Bank, ranked Japan 15th out of 183 countries in which to conduct business, above Germany at 23 and far ahead of China at 89, India at 133 and Russia, 120.

Even in a deflationary environment with little headline growth, the Japanese are purchasing innovative products and ideas. And for certain overseas firms, that provides just the reason to enter the third largest economy.

David S. Abraham is a Council on Foreign Relations/Hitachi International Affairs Fellow and Ira Wolf, a former Assistant U.S. Trade Representative for Japan and China, is now the Japan Representative of PhRMA, the Pharmaceutical Research and Manufacturers of America.